We are fast approaching a new year. For many of us, it is a time for relaxation, taking time off, and enjoying the Holidays. It’s also a great time to take care of those chores that are considered, Not Urgent, but Important. When you own and operate a business, your Buy-Sell Agreement is probably the last thing on your mind. It’s something your advisors drafted years ago and it hasn’t been on your horizon since. However, your Buy-Sell Agreement will eventually become Urgent and Important; you just can’t predict when that moment will occur.
The risk of ignoring your Buy-Sell Agreement is that it may not deliver the desired result when the trigger event occurs. Common deficiencies in Buy-Sell Agreements, from a valuation perspective, are as follows;
- The Agreement is silent on the Standard of Value. The standard of value answers the question, “Value to Whom”. For a strategic buyer, the value of your business will be higher due to synergies. This strategic value, the value to a specific buyer, is very different than “fair market value’, normally defined as from the perspective of a hypothetical buyer, not a specific buyer. Fair market value also includes the application of discounts for marketability and control related to private companies. Most business owners are unfamiliar with “discounts” related to their ownership interest and are shocked to discover they can shave off up to 50% of the proportionate entity value. Your Buy-Sell Agreement must address the standard of value and should affirmatively state if discounts do, or do not, apply. If your agreement is silent, the appraiser will be forced to interpret your intentions, creating the potential for disagreement.
- Valuations based on formulate approaches are ambiguous or outdated. Formulas that are not updated run the risk that current conditions and value multiples have changed drastically from the time the agreement was drafted. It was common years ago to include phrases in the value formula definition such as, “1.5 times book value”, or “book value plus $100,000”. Perhaps those formulas were appropriate 20 years ago, but a lot of things change over 20 years.
For a small fee, we can “test-drive” your buy-sell agreement and calculate the value based on the current terms and provisions, as well as provide you with recommendations so that you know your agreement will deliver the intended result and the safety net you need. Don’t let your buy-sell agreement destroy the value you have created!